OREANDA-NEWS. Fitch Ratings has affirmed Virgin Media Inc.'s (VMED) Long-Term Issuer Default Rating at 'BB-'. The Outlook is Stable. A full list of rating actions is at the bottom of this commentary.

VMED's ratings are supported by its well-established market positions in the UK and Ireland's telecoms markets. The strength of its service offering to the residential and B2B markets is driven by its technology advantage and approach to content aggregation. VMED provides the broadest access to premium content across the UK's pay-TV market and broadband speeds that are likely to remain materially higher than the incumbent's, generating consistent revenue growth, stable margins and strong cash flow. Its mobile operations provide the ability to offer a full convergent service offering.

With funds from operations (FFO) lease adjusted net leverage expected to remain below 5.0x, the company's strong cash flow provides deleveraging capacity available to few of its peers; which we view as a supporting factor for the rating.

KEY RATING DRIVERS

Cash Flow Provides Deleveraging Capacity

VMED is the only meaningfully built-out alternative last-mile communications infrastructure in the UK, with its network passing approximately 45% of the UK's homes and businesses. Its convergent offer is led by its ability to deliver superior broadband speeds combined with the widest access to available video content across the UK's pay-TV platforms. The business delivers consistent revenue growth, stable and high margins and strong cash flow, with underlying 2015 revenue growth of 4% and a pre-distribution free cash flow (FCF) margin of 23%. One of the strongest cash flows in its peer group provides deleveraging capacity available to few of its peers.

VMED targets a net debt/EBITDA range of 4.5x - 5.0x excluding finance leases and vendor finance, which add approximately 0.3x to the reported metric. Under Fitch's calculations, the upper end of this range correlates to FFO net leverage of around 5.3x versus a downgrade guideline of 5.2x. VMED's parent, Liberty Global (LG), targets an upper limit of net debt/EBITDA of 5.0x, including finance leases and vendor finance. In Fitch's view, VMED's importance to the LG group provides financial discipline in line with LG's policy, while VMED's FFO net leverage has historically been managed below 5.0x.

Project Lightning On Track

VMED's plans to cable an additional 4 million UK premises between 2015-2019 is the first major cable extension in many years, with initial build and take-up results suggesting the project is on track. The project's targets include incremental revenues of GBP1.0bn by year 5 and a target EBITDA margin of 60%, reflecting the low incremental operating costs and scale economies of building out an existing network. VMED has reported penetration (customer take-up) of 26% within nine months of initial roll-out/marketing and that customer average revenues per user (ARPU) are in line with its initial target of GBP45. Fitch believes the project's targets are achievable and that management has the flexibility to adapt or pause the project should the operating environment require it.

Technology Advantage

VMED's top commercial broadband speeds are up to 200Mb/s to consumers and 300 Mb/s for businesses in the UK, and its DOCSIS 3.0 cable network is capable of far higher speeds. Fitch considers the UK incumbent BT's network strategy, deploying a combination of fibre to the cabinet while targeting some fibre to the home to be a prudent and economically efficient one, but that cable is likely to continue to benefit from a technology advantage. According to Ofcom data, Openreach is currently able to provide speeds to the majority of households of up to 80 Mb/s. BT's ultrafast broadband plans include G. fast, which is expected to offer speeds up to 500Mb/s. Nonetheless, we expect cable to maintain its speed advantage throughout much of its footprint, regardless of incumbent developments. DOCSIS 3.1, the next generation of cable technology, will enable speeds of 1Gb/s. LG has signalled plans to roll-out the technology across its European operations.

Content Inflation Manageable

VMED's content costs continue to experience inflation. 2015 programming costs of GBP700m were up 12.2%; driven by wholesale access costs of Sky and BT's sports content, who are now competing aggressively for key football rights - most obviously, the English Premier League. VMED successfully defended margins despite these pressures, passing programming inflation onto its video customers along with price increases across its wider fixed line base. VMED's 2015 EBITDA margin of 44.8% improved from 43.7% in 2014.

In Fitch's view, programming inflation remains an ongoing risk across the UK market given evidence of key football rights auctions and the competitive tensions now clearly established to secure these rights. However, the risk for VMED is less pronounced given the position the cable operator takes towards content, establishing itself primarily as an aggregator or access platform to the widest range of available content. We also expect VMED to benefit from Liberty GO, LG's three-year growth plan which includes efficiency programmes aimed at keeping indirect costs flat in absolute terms across the group over the next three years.

OTT and Changing Viewing Habits

VMED competes in a sophisticated TV market and an advanced digital economy. The UK is the fifth-largest communications market in the world and second-largest in Europe. In Fitch's view, the UK and Ireland are progressive markets, likely to continue to lead in terms of changing TV consumption habits. Younger viewers in particular continue to move consumption away from linear viewing to online, on-demand and over the top (OTT) content, while the number of service providers offering triple and quad play is likely to remain high. Fitch believes cable's technology advantage, VMED's access to the widest range of premium content through one access platform and targeted distribution of OTT content like Netflix, to mitigate the near to medium term risks posed by these shifting trends.

Competitive, Rational Market

Despite a high degree of competition Fitch considers the UK communications market to be rational, particularly the fixed consumer and small business segments important to VMED. Pricing in fixed services and TV has proven resilient, with service providers across the market consistently proving an ability to increase prices. The advanced nature of the market provides a degree of support for pricing in the UK with consumers willing to pay for premium content and high bandwidth. This feature is likely to continue as household device proliferation and demand for video streaming grow.

In Fitch's view, the enlarged BT/EE offers a more direct threat to the mobile operators in view of its enhanced position to offer convergent (fixed/mobile) services; and less so to VMED. Used primarily as a churn management tool, VMED has roughly 3 million mobile customers including 1 million converged customers. However, we do not view mobile as a key cash flow or growth driver for VMED.

Regulatory Visibility

UK regulator, Ofcom, published the initial findings of its digital communications review in February 2016. The regulator identified that VMED's cable coverage will increase to around 60% once Project Lightning is complete, noted cable's technology advantage and that the development of the cable industry has helped drive investment by the incumbent. It did not touch on wholesale cable access. In Fitch's view, this is not a significant near to medium term risk. Pressure is only likely if cable was found to have significant market power. At present it has roughly 20% broadband market share and 45% in footprint. Although the latter is relatively high, Fitch believes the regulator would be concerned with national share and is also likely to view VMED's investments as positive to broadband access generally in the UK.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for VMED include:-

-Mid-single revenue growth in 2016; increasing in 2017 and beyond as Project Lightning investment delivers meaningful revenues

-Modest EBITDA margin dilution in 2016 reflecting programming inflation ; improving thereafter and exceeding 45% by 2018, given scale economies and the low marginal costs of incremental subscribers from Project Lightning

-Capex/sales ratio remaining above 30% over the next three years due to Lightning

-Operating metrics associated with Lightning in line with the shape of management targets but assumed to be moderately more conservative

- Net debt/EBITDA (including finance leases and vendor finance) to be managed close to 4.9x, with excess cash flows repatriated to LG in the form of payments under a shareholder loan.

RATING SENSITIVITIES

Future developments that may, individually or collectively, lead to negative rating action include:

- FFO adjusted net leverage that was expected to remain above 5.2x on a sustained basis.

- FFO fixed charge cover that was expected to remain below 2.5x on a sustained basis.

- Material deterioration in underlying FCF generation. Our rating case assumes a pre-distribution FCF margin excluding Lightning investment in the mid-teens.

- Material decline in operational metrics, as evidenced by declining key performance indicators, such as customer penetration, revenue generating units per subscriber and ARPUs. Evidence that investment in Project Lightning is being scaled to proven demand will be an important operating driver.

Future developments that may, individually or collectively, lead to positive rating action include:

-A firm commitment by VMED that it is adopting a more conservative financial policy (for example, FFO adjusted net leverage of 4.5x).

- Continued sound operational performance, as evidenced by KPI trends and progress in both investment and consumer take-up with respect to Project Lightning.

LIQUIDITY

Fitch considers liquidity sound with unrestricted cash and cash equivalents of GBP188m and availability under its GBP675m revolving credit facility of GBP299m as at 1Q16.

FULL LIST OF RATING ACTIONS

Virgin Media Inc.

- Long-Term IDR: affirmed at 'BB-'; Outlook Stable

- Short-Term IDR: affirmed at 'B'

Virgin Media Secured Finance Plc

- Senior secured debt rating: affirmed at 'BB+','RR1'

Virgin Media Investment Holdings Limited

- Senior secured debt rating: affirmed at 'BB+','RR1'

Virgin Media Finance PLC

- Senior notes affirmed at 'B','RR6'